why do demand slopes downward?

- operation of the law of diminishing marginal utiity.

this law tells us that the more of consumer consumes a commodity smaller its marginal utility will be to
him. when price declines theconsumer will find it benifical to buy these units as their marginal utility will
now exceed the new price.

the consumer make sacrifice of money many times till the utility derieved from the commmodity is
greater than the money sacrificed.

-Income effect

when there is fall in price of income it implies the rise in the real income of the consumer. with larger
income a person normally buys more of a commodity.

-Substitution effect

if the price of a particular product increases the consumer shift over to other brand.

-New consumers creating demand

when the price of a commodity falls some new users get interested in buying them.

Exceptions to law of demand

in certain cases, an increaese in the prices of some goods leads to an increase in their demand.
alternatively when this price fals heir demand also falls. this unsual of demand is considered as its
exception to the law of demand.

1. Giffin goods
Sir Robert Giffin obsserved that the rise in price of bread cost low paid british wage earners to buy
more quantities if bread and not less.
This is coz they consiider bread as their main food item. whenever there was rise in price their real
income used to shrink and they were forced to cut down the consumtion of meat and other expensive
food items. To maintain their intake of food they therefore bought more bread even at a higher price.
This phenomenon is reffered as Giffins Paradox.
In India the example of giffin good is bajra which is compared with wheat. it was observed that when the
price of bajra wen doen its consumption also increased and the consumption of wheat fell. This is coz
wheat is more expensive than bajra. hence to compensate the increased price of bjara the consumer
reduced the consumption of wheat.

2. Expectation of future rise in price

when the price of commodity is increasing and consumers expect a future rise in its price they will try
to store more and more quantities of that commodity. therefore even though the price rises the demand
will increase instead of falling.

3. Incase of emergency
in this time the price of good or commodity increases but the demand also increases. eg: in case of
natural disaster.

4. Demand for goods configuring social prestige/snob effect. these goods are bought for the purpose of
showing off in the society. eg: vintage cans, diamonds ,designer wear etc.

5.change in fashion
In certain cases a change in fashion forces a behaviour pattern that is just opposite to the law of
demand. it refers to kind of demonstration effect or hard mentality where a section of the society tends
to initiare a popular celebrity/character. this is generally seen in cases of fashion tends , children toys and
accessories. it is also known as brand wagon effect.

6.ueblen
these goods have low practical value but high prestige value. Generallly thse gooods have
historical/cultural value importance. ex: antique pieces.

7. habit forming goods

demand for goods like cigrette and alcohol remains relatively unchanged as the consumers who use
them become addidcted to them.

MOVEMENT ALONG THE SAME DEMAND CURVE

movement along the same demand curve occurs when price of commodity changes keeping other
factors constant. when Q1 quantity is demanded at price P1. even excise duty imposed the manufacturer
raises the price from P1to P2. As per the law of demand quantity demanded falls from Q1to Q2. This is
known as contarction or reduction in QD. Similarly if the price falls the QD expands to Q3 from Q1. The
movement from Q1-Q3 is known as expansion.

SHIFT IN DEMAND CURVE

the demand curve shifts towards right/left and there is change in factors other than price. In
this curve, at price P, Q1 is QD. If the price does not change, but the income of consumer
increases, the demand curve DD will shift outwards and demand increases from Q1to Q2.
Similarly if there is change in prefernce of consumers and demand falls to Q3 the demand curve
will shift inwards.

ELASTICITY OF DEMAND
1. price elasticity of demand refers to the magnitude of change in demand due to change in its
price. it measures the respnsiveness of the demand of a good to a change in its price.

Cp/CD = %change in QD/ % change in price

Q2-Q1/Q1*100/ P2-P1/P*100

deltaQ/deltaP*P/Q

The coeffecient of demand elasticity is negetive coz quantity and price share an inverse relation.
1.when the demand for a product doesnt change as a result of change in its price, demand is said to be
perfectly in elastic.

2. inelastic demand- when a change in price leads to a less propotioante change in demand, demand is
said to be less elastic. The coeffecient of price elasticity in this case is(0<Ed<1). It exists in case of
necessity items like good and fuel.

3. when the percentage change in quantity demanded is equal to percentage change in price the
demand is said to be unitary elastic. it exists in case of normal goods.

4.Elastic- when change in price leads to more than propotionate change in demand, the demand is said
to be highly elastic. The elasticity increses as the absolute value of elasticity coeffecient increaes. It exists
in case of luxurious goods.

5. Perfectly elastic- in this case when the demand of commodity increases or decreses any change in
price demand is said to be perfectly elastic. In this case we are assuming the price is constant and all the
sellers are selling homogenous product. The coeffecient of demand is infinity. eg: vegetables in organised
vegetable market.
FACTORS AFFECTING PRICE ELASTICITY OF DEMAND

· nature of goods

· degree of neccesity or luxury

· no. of substitutes available

· percentage of income(total)

· habitual goods

· time period

· alternate no. of uses

· joint demand (complimetary goods)

· fashion, taste and preferences of consumers

MEASURING PRICE ELASTICITY OF DEMAND

1. Total expenditure method

Dr. Marshal has evolved the total expenditure method to measure the price elasticity of demand. Acc.
to this method elasticity of demand can be measured by considering the change in price and the
subsequent change in the total quantity of good purchased and the total amount of money spent on it.

total outlay=quantity demanded* price

According to this method Ed is studied in relation to change in total expenditure as a result of change in
price (and the consequent change in demand). In case I elasticty is 1 when the price decreases from rs5
to rs4 and quantity increases from 100 to 125.
2. Geometric method/Arch price/Point elasticity of demand
this method enables us to calculate elasticity of demand at different points of linear demand curve. In
fig 1 elasticity of demand is 0 at point B because the lower segment is 0. As we move up the demand
curve, elasticity of demand increases. However it remains less than unity in the range PB as in this entire
range the lower segment is less in length as compared to the upper segment. At point P(mid point) the
two segments are equal. therefore elasticity is unitary. As we move further up, the length of lower
segment becomes more than the length of upper segment. Accordingly as we move up from P to A,
elasticity of demand increaes and remains greater than unitary throghout the range PA. When we reach
A, the upper segment becomes zero therefore elasticity becomes infinite.

IMPORTANCE OF PRICE ELASTICITY OF DEMAND

1. pricing decisions in b/s firms

A b/s firm may use the concept of price elasticity of demand to determine the change in its demand
even if it decides to change the price. It helps the firm expand amd manage existing stocks. Also it
enables the firm to tackle competetion in a better way.

2. Govt. policy making

the central and state govt. use the concept of price elasticity of demand in order to decide and levy
certain taxes and duties for all products. eg: for inelastic habitual commodities like alcohol and tobacco
goods have high taxes imposed on them, since the govt. wants to discourage their production. similarly
other commodities like food and fuel are not taxed much rather subsidies are provided on them as they
are necessities.
Items like jwellery, designer wear and watches are heavily taxed since they are purchased by high
income.

3. Decisions of the govt relating to MSP

Before the introduction of MSP, Indian farmers used to suffer in poverty whenever there was bumper
harvest due to fall in market prices, resulting from excessive supply. To avoid this fall in market price they
set the produce on fire in order to reduce the market supply.
Since food grains are inelastic in nature the govt. had to import from other countries at a higher price
when there was a crop failure. To rectify this situation and protect the farmers interest the govt set up,
MSP below which no farmer would have to sell. In times of proper harvest the govt. purchases entire
food grains at procurement price and save it for later.

INCOME ELASTICITY OF DEMAND

Ey= %change in QD/%change in income ie. deltaQ/deltaY*Y/Q

It measures the degree of responsiveness to which quantity demanded responds to a chnage in

income(cetris paribus).

· income elasticity is +ve in case of normal goods as income and QD share a direct relationship.

· Ey is -ve in case of inferior goods as the QD of inferior goods falls with increase in income. This is
coz as income increaes the consumer consumes less of inferior goods as he now can afford
more of normal good.

TYPES OF Ey

1. High income elasticity

in this case the quantity demanded of the good increaes by a larger percentage as compared to the
income of the consumer. eg: luxurious goods. Ey>1

2.Unitary income elastiicity

in this case the % change in QD is equal to % change in income. Ey=1

3.Low income elasticity

the % change in QD is less than % change in income. Ey<1
4. Zero income elasticity
this depicts a case where a change in income does not lead to any change in QD.

5. Negetive income elasticity

in this case with the rise in the level of income the QD actually falls. Ey=0

CROSS PRICE ELASTICITY

Ec= % change in quantity x/ % change in qty Y= delta Qx/delta Py*Py/Qx

it is the measure of the quantity demanded of good X due to the change in price of good Y. in other
words it meaures the responsiveness of demand of one product to change in price of related product.

TYPES

1. Positive infinity( Ec=+infinity)